MGT499- W7 Post and Response
INeal
Roth4_SM_Lecture_PPT_C12_Final1.pptxCHAPTER 12
Corporate Governance and Business Ethics
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Be sure to see the NEW Teacher’s Resource Manual located in the Connect Library under Instructor’s Resources.
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The AFI Strategy Framework
Exhibit 1.3
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Learning Objectives
LO 12-1 Describe the shared value creation framework and its relationship to competitive advantage.
LO 12-2 Explain the role of corporate governance.
LO 12-3 Apply agency theory to explain why and how companies use governance mechanisms to align interests of principals and agents.
LO 12-4 Evaluate the board of directors as the central governance mechanism for public stock companies.
LO 12-5 Evaluate other governance mechanisms.
LO 12-6 Explain the relationship between strategy and business ethics.
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The Shared Value Creation Framework
Provides guidance to managers
Helps reconcile:
Gaining and sustaining competitive advantage and
Corporate social responsibility
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Instructors:
The digital companion to this book McGraw-Hill Connect has a video case exercise on this section of the textbook. It builds student confidence on creating value and sustainability. (LO 12-1).
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The Public Stock Company: Four Benefits
Limited liability for investors
Transferability of investor ownership
Through the trading of shares of stock
Legal personality
Rights and obligations
Separation of legal ownership and management control
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The public stock company enjoys these four characteristics that make it an attractive corporate form.
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The Public Stock Company: Hierarchy of Authority
Exhibit 12.1
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This image depicts the levels of hierarchy within a public stock company. The state or society grants a charter of incorporation to the company’s shareholders—its legal owners, who own stock in the company. The shareholders appoint a board of directors to govern and oversee the firm’s management. The managers hire, supervise, and coordinate employees to manufacture products and provide services.
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Milton Friedman’s Philosophy
“The social responsibility of business is to increase its profits.”
A survey was created:
For the (degreed) top 25% of income earners
To assess various countries
To inquire whether they agree with Milton Friedman
The results…
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Percent of “Informed Public” Who “Strongly/Somewhat Agree” with Friedman
Exhibit 12.2
SOURCE: Author’s depiction of data from Edelman’s (2011) Trust Barometer as included in “Milton Friedman goes on tour,” The Economist, January 27, 2011.
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The countries where the fewest people agreed with Friedman’s philosophy were China, Brazil, Germany, Italy, and Spain; fewer than 40 percent of respondents in those countries supported an exclusive focus on shareholder capitalism. Although they have achieved a high standard of living, European countries such as Germany have tempered the free market system with a strong social element, leading to so-called social market economies. The respondents from these countries seemed to be more supportive of a stakeholder strategy approach to business. Some critics, however, would argue that too strong a focus on the social dimension contributed to the European debt crisis because sovereign governments such as Greece, Italy, and Spain took on unsustainable debt levels to fund social programs such as early retirement plans, government-funded health care, and so on. The United States placed roughly in the middle of the continuum—a bit more than half (56 percent) of U.S. respondents subscribed to Friedman’s philosophy.
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Creating Shared Value
Michael Porter’s view:
Executives shouldn’t concentrate only on increasing firm profits.
Rather, they should focus on creating shared value.
Economic value (for shareholders)
Social value (address society’s needs and challenges)
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GE, for example, has strengthened its competitiveness by creating a profitable business with its “green” Ecomagination initiative. Ecomagination is GE’s strategic initiative to provide cleaner and more efficient sources of energy, provide abundant sources of clean water anywhere in the world, and reduce emissions. Jeffrey Immelt, GE’s former CEO, would often say, “Green is green,” meaning that addressing ecological needs offers the potential of gaining and sustaining a competitive advantage for GE. Through applying strategic innovation, GE is providing solutions for some tough environmental challenges, while driving company growth at the same time. Ecomagination solutions and products allow GE to increase the perceived value it creates for its customers while lowering costs to produce and deliver the “green” products and services. Ecomagination allows GE to solve the trade-off between increasing value creation and lowering costs. This in turn enhances GE’s economic value creation and its competitive advantage.
Instructors:
The digital companion to this book McGraw-Hill Connect has a video case exercise on this section of the textbook. It builds student confidence on creating value and sustainability. (LO 12-1).
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Porter’s Recommendations to Reconnect Economic & Societal Needs
Expand the customer base
Bring in nonconsumers (largest and poorest groups)
Expand traditional internal firm value chains.
Include more nontraditional partners (non-profits)
Focus on creating new regional clusters:
Such as Silicon Valley
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Porter argues that these strategic actions will lead to a larger pie of revenues and profits that can be distributed among a company’s stakeholders.
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Corporate Governance
The mechanisms to:
Direct and control an enterprise
Ensure that it pursues strategic goals successfully and legally
Offers checks and balances
Attempts to address the principal-agent problem
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Instructors:
The digital companion to this book McGraw-Hill Connect has an application exercise on this section of the textbook. It builds student confidence on corporate governance and its misuse….creating ethical issues for firms and stakeholders. (LO 12-2 & 12-3).
The separation of ownership and control is one of the major advantages of the public stock companies. This benefit, however, is also the source of the principal–agent problem. In publicly traded companies, the stockholders are the legal owners of the company, but they delegate decision-making authority to professional managers. The conflict arises if the agents pursue their own personal interests, which can be at odds with the principals’ goals. For their part, agents may be more interested in maximizing their total compensation, including benefits, job security, status, and power. Principals desire maximization of total returns to shareholders.
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The Principal-Agent Problem
Exhibit 12.3
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Managers, executives, and board members tend to have access to private information concerning important company developments that outsiders, especially investors, are not privy to. Often this informational advantage is based on timing—insiders are the first to learn about important developments before the information is released to the public. Although possessing insider information is not illegal and indeed is part of an executive’s job, what is illegal is acting upon it through trading stocks or passing on the information to others who might do so. Insider-trading cases, therefore, provide an example of egregious exploitation of information asymmetry.
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Agency Theory
A theory that views the firm as a nexus of legal contracts
Conflicts that arise should be resolve legally.
The firm needs to design work tasks, incentives, and employment contracts.
To minimize opportunism by agents
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Senior executives, such as the CEO, face agency problems when they delegate authority. Employees who perform the actual operational labor are agents who work on behalf of the managers. Such frontline employees often enjoy an informational advantage over management. They may tell their supervisor that it took longer to complete a project or serve a customer than it actually did, for example. Some employees may be tempted to use such informational advantage for their own self-interest (e.g., spending time on Facebook during work hours, watching YouTube videos, or using the company’s computer and internet connection for personal business).
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Adverse Selection and Moral Hazard
Both caused by information asymmetry
Adverse Selection
An increased likelihood of selecting inferior alternatives
Moral Hazard
When one party is incentivized to take undue risks or shirk responsibilities because the costs incur to the another party
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The Board of Directors
Represent the interests of shareholders
Tasked with providing oversight
Consist of inside and outside directors
Inside directors: usually consist of: CEO, COO, CFO
Outside directors: senior execs from other firms
Are elected by the shareholders
Shareholders vote to determine who is elected
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Responsibilities of the Board of Directors
Strategic oversight and guidance
CEO selection, evaluation, compensation
Oversight of CEO succession
Guide executive compensation
Review, monitor, evaluate, and approve strategic initiatives
Such as large acquisitions
Risk assessment & mitigation
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Other Mechanisms to Align Incentives Between Principals & Agents
Executive compensation
The market for corporate control
Financial statement auditors, government regulators, and industry analysts
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1: Executive Compensation
Stock options are often part of compensation.
The average ratio of CEO to employee pay is 300:1.
About 2/3 of CEO pay is linked to firm performance.
Incentives can negatively affect performance
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Based on a 2017 survey of CEOs in the S&P 500 by The Wall Street Journal, the median annual compensation was about $11 million. The five highest paid CEOs were Thomas Rutledge of Charter Communications ($98.5 million), Fabrizio Freda of Estée Lauder ($48.4 million), Mark Parker of Nike ($47.6 million), Alex Molinaroli of Johnson Controls ($46.4 million), and Robert Iger of Disney ($43.9 million). Noteworthy are also the two lowest paid CEOs in the S&P 500: Warren Buffett of Berkshire Hathaway ($470,000) and Larry Page of Alphabet ($1, the minimum payment required)
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2: The Market for Corporate Control
An external corporate-governance mechanism
Activist investors who:
Seek to gain control of an underperforming corporation
Buy shares of its stock in the open market
Through leveraged buy outs
Defended by poison pills
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In a leveraged buyout (LBO), a single investor or group of investors buys, with the help of borrowed money (leveraged against the company’s assets), the outstanding shares of a publicly traded company in order to take it private. In short, an LBO changes the ownership structure of a company from public to private. The expectation is often that the private owners will restructure the company and eventually take it public again through an initial public offering (IPO).
To avoid being taken over against their consent, some firms put in place a poison pill. These are defensive provisions that kick in should a buyer reach a certain level of share ownership without top management approval.
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3: Auditors, Government Regulators, And Industry Analysts
External-governance mechanisms
To avoid misrepresentation of financial results:
Public financial statements must follow GAAP:
Generally accepted accounting principles
Financial statements must be audited
Industry analysts often base their buy, hold, or sell recommendations on:
Financial statements filed with the SEC
Business news (WSJ, Forbes, CNBC, etc.)
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Corporate-governance mechanisms play an important part in aligning the interests of principals and agents. They enable closer monitoring and controlling, as well as provide incentives to align interests of principals and agents. An industry has sprung up around assessing the effectiveness of corporate governance in individual firms. Research outfits, such as GMI Ratings, provide independent corporate governance ratings. The ratings from these external watchdog organizations inform a wide range of stakeholders, including investors, insurers, auditors, regulators, and others.
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Business Ethics
An agreed-upon code of conduct in business
Provides training for:
“behavior that is consistent with the principles, norms, and standards of business practice that have been agreed upon by society”
Can differ in various cultures around the globe
Universal norms include:
Fairness, honesty, reciprocity
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Instructors:
The digital companion to this book McGraw-Hill Connect has a video case exercise on this section of the textbook. It builds student confidence on leadership providing ethical guidance. It also brings in a global perspective using an example from a firm in South Africa that reflects back on Apartheid. (LO 12-6).
Law and ethics, however, are not synonymous. This distinction is important and not always understood by the general public. Staying within the law is a minimum acceptable standard. A note of caution is therefore in order: A manager’s actions can be completely legal, but ethically questionable.
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When Facing an Ethical Dilemma
Is the action within acceptable norms of professional behavior?
As outlined in the organization’s code of conduct
As defined by the profession at large
Would you feel comfortable explaining and defending the decision in public?
How would the media react?
How would the company’s stakeholders feel about it?
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Bad Apples vs. Bad Barrels
Bad Apples
Individuals who act opportunistically
Bad Barrels
An unethical organizational climate
To set the ethical tone, leaders must:
Set clear ethical expectations
Put structure, culture and control systems in place
Culture must be aligned
Executive behavior must adhere to values
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The MBA Oath
Helps anchor future managers to professional values
Has been taken by:
6,000 MBA students
Students in over 300 institutions around the world
A guideline for integrity in business
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The MBA Oath (1 of 2)
As a business leader I recognize my role in society.
My purpose is to lead people and manage resources to create value that no single individual can create alone.
My decisions affect the well-being of individuals inside and outside my enterprise, today and tomorrow.
Therefore, I promise that:
I will manage my enterprise with loyalty and care, and will not advance my personal interests at the expense of my enterprise or society.
I will understand and uphold, in letter and spirit, the laws and contracts governing my conduct and that of my enterprise.
I will refrain from corruption, unfair competition, or business practices harmful to society.
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www.mbaoath.org
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The MBA Oath (2 of 2)
I will protect the human rights and dignity of all people affected by my enterprise, and I will oppose discrimination and exploitation.
I will protect the right of future generations to advance their standard of living and enjoy a healthy planet.
I will report the performance and risks of my enterprise accurately and honestly.
I will invest in developing myself and others, helping the management profession continue to advance and create sustainable and inclusive prosperity.
In exercising my professional duties according to these principles, I recognize that my behavior must set an example of integrity, eliciting trust and esteem from those I serve. I will remain accountable to my peers and to society for my actions and for upholding these standards.
This oath I make freely, and upon my honor.
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www.mbaoath.org
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Appendices Descriptions of Visual Graphics to Support Student Accessibility Needs
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Appendix 1 The AFI Strategy Framework
The important inside circle is titled "Gaining and Sustaining a Competitive Advantage" that is at the very center of the image, with five different circles on the outside of it. Arrows go back and forth from the center circle to each of the five outer circles. The five outer circles are labeled: (1) Getting Started, (2) External and Internal Analysis, (3) Formulation: Business Strategy, (4) Formulation, Corporate Strategy, and (5) Implementation.
Each of these outer five circles have a brief description beside them to explain what the circle means:
Under the first outer circle titled "Getting Started," it says: Part 1, Strategy Analysis, "What is Strategy (Chapter 1)" and "Strategic Leadership: Managing the Strategy Process (Chapter 2)."
Under the second outer circle titled "External and Internal Analysis," it says: Part 1, Strategy Analysis, "External Analysis: Industry Structure, Competitive Forces and Strategic Groups (Chapter 3)," "Internal Analysis: Resources, Capabilities and Core Competencies (Chapter 4)," and "Competitive Advantage, Firm Performance, and Business Models (Chapter 5)."
Under the third outer circle titled "Formulation: Business Strategy," it says: Part 2, Strategy Formulation, "Business Strategy: Differentiation, Cost Leadership and Integration (Chapter 6)" and "Business Strategy, Innovation and Entrepreneurship (Chapter 7)."
Under the fourth outer circle titled "Formulation: Corporate Strategy," it says: Part 2, Strategy Formulation, "Corporate Strategy: Vertical Integration and Diversification (Chapter 8)," "Corporate Strategy: Strategic Alliances, Mergers and Acquisitions (Chapter 9)," and "Global Strategy: Competing Around the World (Chapter 10)."
Under the fifth outer circle titled "Implementation," it says: Part 3, Strategy Implementation, "Organizational Design: Structure, Culture and Control (Chapter 11)," and "Corporate Governance and Business Ethics (Chapter 12)."
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Appendix 2 The Public Stock Company: Hierarchy of Authority
Starting at the top: State Charter, then Shareholders, then Board of Directors, then Management, then Employees.
The state or society grants a charter of incorporation to the company’s shareholders—its owners, who legally own stock in the company. The shareholders appoint a board of directors to govern and oversee the firm’s management. The managers hire, supervise, and coordinate employees to manufacture products and provide services.
©McGraw-Hill Education.
Appendix 3 Percent of “Informed Public” Who “Strongly/Somewhat Agree” with Friedman
The survey asked the top 25 percent of income earners holding a university degree in each country surveyed whether they agree with Milton Friedman’s philosophy that “the social responsibility of business is to increase its profits.” The results, as displayed in this graph, revealed some intriguing national differences.
United Arab Emirates: about 82 percent.
Japan: 70 percent.
India: a little less than 70 percent.
South Korea: 66 percent.
Singapore: 66 percent.
United States: 55 percent.
China: a little less than 40 percent, 38 percent.
Brazil: about 37 percent.
Germany: 35 percent.
Italy: 34 percent.
Spain: 33 percent.
(approximate totals)
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Appendix 4 The Principal-Agent Problem
This image shows two circles titled Principal and Agent with arrows pointing to each other. The arrow pointing from Principal to Agent says "hires, monitors and compensates," and the arrow pointing from agent to principal says "performs work, provides time and talents." In the middle of these circles are the words "information asymmetry."
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